Unit 2: Trade Policy
Trade in Developing Countries
2/27/2012
Developing Countries
Developing countries has
no precise definition, but it
generally refers to low and
middle income countries.
There is a large disparity
between high and low
income countries.
Import Substitution
infant industry argument –
temporary protection of industries
allows them to gain experience
and thus economies of scale
Import Substitution
import-substituting
industrialization –
the strategy of encouraging
domestic industry by limiting
imports of manufactured goods
Import Substitution
Import-substituting
industrialization was a trade
policy adopted by many lowand middle-income countries
before the 1980s.
It aimed to encourage
domestic industries by
limiting competing imports.
Import Substitution
Import Substitution
Countries may have a potential
comparative advantage in certain
industries, but they cannot initially
compete with well-established
competitors in other countries.
Therefore governments should
temporarily support them until
they can compete internationally.
Import Substitution
Infant industry argument problems
It may be wasteful to support
industries now that will have a
comparative advantage in the future.
With protection, infant industries may
never grow up or become competitive.
Import Substitution
Infant industry argument problems
There is no justification for government
intervention unless there is a market
failure that prevents the private sector
from investing in the infant industry.
Import Substitution
Possible market failures
Because of poorly working financial
markets, firms cannot save and borrow
to invest in their production processes.
High tariffs could be a second-best
policy instead of fixing financial market.
Of course a far better solution is the
first-best policy: fix the financial market.
Import Substitution
Possible market failures
Firms may not be able to privately
appropriate the benefits of their
investment in new industries because
those benefits are public goods.
The knowledge created when starting
an industry may not be appropriable
(may be a public good) because of a
lack of property rights.
Import Substitution
Possible market failures
High tariffs could be a second-best
policy instead of establishing a
system of property rights.
Of course as always a far better
solution is the first-best policy:
establish a system of property rights.
Import Substitution
Import-substituting industrialization
in Latin American countries worked
to encourage manufacturing
industries in the 1950s and 1960s.
But high tariff import substituting
countries grew slower than low tariff
countries with export oriented growth.
Import Substitution
The infant industry argument was not as
valid as some had initially believed.
New industries did not become
competitive due to of trade restrictions.
Import-substitution was very wasteful:
• complex, time-consuming regulations
• high tariff rates for consumers
• high tariff rates for firm inputs
• inefficiently small industries.
Trade Liberalization
Countries that had relatively free trade
had higher average economic growth
than import-substituting countries.
Many governments lost faith in import
substitution and began to liberalize.
In the mid-1980s India and Brazil
dramatically lowered their tariff rates.
Trade Liberalization
Fig. 11-1: Tariff Rates in Developing Countries
Trade Liberalization
Fig. 11-2: The Growth of Developing-Country Trade
Trade Liberalization
The empirical evidence on trade
liberalization is mixed.
Growth rates in Brazil and other Latin
American countries have been slower
than under import-substitution.
This slowness may be attributable to
other bad policies though (lack of
property rights and financial crises).
Trade Liberalization
India has grown rapidly.
The Asian miracles Japan, Hong Kong,
Taiwan, South Korea, Singapore,
Malaysia, Thailand, Indonesia, and
China have also grown rapidly – both in
their export sectors and overall.
Other factors may have played a role
in the amazing Asian growth.
Trade Liberalization
Fig. 11-3: The Asian Takeoff
Trade Liberalization
Fig. 11-4: Asia’s Surging Trade
Trade Liberalization
It’s unclear if the high volume of
exports and imports caused rapid
economic growth or was merely
correlated with rapid growth.
Other possibilities
• High saving and investment rates.
• Rapid growth in education.
• Other economic reforms.